Articles

Forecasting in a VUCA World: 2 Approaches for FP&A

By RongFang Lye

Published: 10/26/2018

Forecasting is challenging—and even more so in the current volatile, uncertain, complex, and ambiguous (VUCA) environment businesses now operate in. Here are two approaches to forecasting in a VUCA world for financial planning and analysis (FP&A) professionals.

“Oh no… not again,” said the Operation Manager as we began another round of quarterly forecasting in the hallway at the office. A familiar scene regularly plays out in offices around the world every day—forecasting, a process that is necessary yet painful for many. This is especially so in the current volatile, uncertain, complex, and ambiguous (VUCA) environment businesses now operate in.

Before VUCA, the world was a much simpler environment. We did our quarterly forecast with the usual grumble from the various stakeholders and at the end of each quarter, the actuals following closely with the forecast. Everyone congratulated themselves for surviving another quarter as forecasted.

In the new VUCA world, forecasting is much more of an art than science as political, economic, social, technological, environmental, and legal changes lead to rapid impacts on forecasting. It brings into question the realism of forecasting and its usefulness in decision making.

In past situations, the forecasting process used to start with the actual figures for the months that have passed. Then, forecasters tried to fill the rest of the year either to meet expectations of senior management, keeping to the budget or simply reflecting the current expectations of what is coming. This was always a battle of interest between various stakeholders and the final output of the forecast was the result of the consensus of the various stakeholders.

Some people have argued that forecasting is just Budgeting 2.0 in which everyone would take this opportunity to try to influence the numbers either to improve or lower the budgeted figures. On this, I will agree, because forecasting is usually the window of opportunity to revisit the first assumptions put up in the budget. The goal was to correct any excitement, expectation and elation from the first round of budgeting to reflect a more realistic number in the forecast.

FORECASTING IN A VUCA WORLD

In the VUCA world, this is no longer the case. The fast pace of the changes in a range of factors speedily undermine all assumptions created in the forecast. The forecast became stale as soon as it goes into print. Businesses are having a challenging time keeping up with this pace in the VUCA world. To keep up with this challenge, I propose the following tools to cope:

Rolling Forecast. A rolling forecast always operates on a 12-month basis—for example, January to December or February to January. In this way, forecasting is carried out monthly and is constantly updated each month to decide the validity of the assumptions. Through this method, the forecast is always attuned to the changing VUCA environment.

A rolling forecast also enables senior management to constantly measure the effectiveness of their strategy and at the same time allow them to make prompt adjustment to accommodate the changing environment. At the same time, it also means that on a monthly basis, time must be set aside for various stakeholders to provide their inputs to the forecasting process—hence, adding more burdens to their current workload.

Dynamic Forecasting. Dynamic forecasting is a forecast that is based on a set of assumptions. Every quarter, a set of assumptions are entered into the model to generate a set of numbers, and adjustments are made to reflect the new reality. The assumptions are challenged quarterly to confirm their reflection of the actual business environment. In this way, the forecast is always a correct reflection of the views of the operational managers and this will enable the senior management to have a correct picture of what is to come in the following quarters.

The differences between dynamic forecasting and rolling forecasting is that the former needs quarterly inputs while the latter requires monthly updates. In addition, with rolling forecasting, the organisation also needs to shift toward continuous accounting to enable the details to be accurately reflected. This requires a major shift in mindset, as most accounts preparers are used to the antiquated concept of financial close at the end of the month. All these changes require a change management program to be put in place before dynamics forecasting can be successfully implemented.

Overall, the agility of an organisation, the people and the processes in place will determine the success of the switch to a more relevant forecasting process in a VUCA world. The VUCA world is the new reality and to successfully manage the risks and emerge stronger, a better method in forecasting has to be put in place to deal with the challenges identified.